1.1. A is a debt trading company (Debt Purchaser).
1.2. B (Debt Seller) is a party that sells goods to the buyers (Goods Buyer) under a goods sale and purchase contract (Goods Sale & Purchase Contract).
1.3. B wants to transfer the receivables under the Goods Sale & Purchase Contract (Receivables) to A with the consent and acceptance of the Goods Buyer at the agreed debt sale price (Purchase Price).
1.4. A and B have entered into a debt sale and purchase agreement (Debt Sale & Purchase Agreement) whereby if the Goods Buyer fails to pay the Receivables to A when due (Event of Default), A has the right to cancel the Debt Sale & Purchase Agreement, and request B to receive the re-transfer of the Receivables and return the Purchase Price to A (Cancellation Right). A may also request B to pay a late payment interest calculated as a percentage of the Purchase Price from the date A pays the Purchase Price to B until B returns the Purchase Price to A (Late Payment Interest).
Question: Is A's Cancellation Right considered as the right to recourse in factoring?
2.1. Under Article 4.17 of the Law on Credit Institutions of the National Assembly dated 16 June 2010 (as amended) (Law on Credit Institutions 2010) and Article 3.9 of Circular 2 of the State Bank of Vietnam dated 17 May 2017 on factoring activity of credit institutions, foreign bank branches (Circular 2/2017), “factoring” (specifically, factoring of the goods seller) is defined as a form of granting credit to the goods seller through the credit institution’s repurchase with reservation of the right to recourse to the receivables of the customer being the goods seller via advancing an amount of money to receive the legitimate rights and interests related to the receivables under an agreement. As such, one of the basic elements of factoring activities of the goods seller is that the credit institution (Credit Institution) reserves the right to recourse to the receivables from the goods seller.
2.2. According to Article 3.5 of Circular 2/2017, reservation of the right to recourse means that the Credit Institution has the right to reclaim the advanced amount and interest, factoring fees from the customer in the event that the goods buyer fails to fulfill the payment obligation with respect to the payable amount.
2.3. In the above example of debt sale and purchase, when an Event of Default occurs, the Debt Purchaser has the Cancellation Right. The Cancellation Right in the Debt Sale & Purchase Agreement is structured on the basis of the “right to cancel transaction” under Article 423.1(a) of the Civil Code of the National Assembly dated 24 November 2015 (Civil Code 2015). When the contract is cancelled, then according to Article 427 of the Civil Code 2015:
2.3.1. the contract becomes invalid as from the time when it was entered into, the parties are not required to perform the agreed obligations, except for the agreement on penalty for breach, compensation for damage and agreement on dispute settlement; and
2.3.2. the parties must return to each other what they have received from the other party after deducting reasonable costs during the performance of the contract and costs for preservation and development of property. Where [all or both] the parties have an obligation to return, restitution must be implemented at the same time, unless otherwise agreed or unless otherwise provided by law.
2.4. Comparing the concept of the right to recourse in factoring under Circular 2/2017 and the concept of contract cancellation under Article 427 of the Civil Code, there are some basic differences as follows:
2.4.1. According to the Law on Credit Institutions 2010, the Credit Institution’s exercise of the right to recourse does not result in the invalidation of the contract from the time it was entered into. Meanwhile, when the Debt Purchaser exercises its Cancellation Right upon the occurrence of the Event of Default, the Debt Sale & Purchase Agreement will be considered invalid from the time it was entered into except for the clause on penalty for breach, compensation and dispute settlement.
2.4.2. According to the Law on Credit Institutions 2010, the Credit Institutions have the right to withhold the Receivables when exercising the right to recourse in factoring. Meanwhile, when the Debt Purchaser exercises the Cancellation Right upon the occurrence of the Event of Default, the Debt Purchaser is obliged to return the receivables to the Debt Seller. The specific analysis is as follows:
(a) With respect to factoring activities: Circular 2/2017 does not clearly stipulate when the Credit Institution exercises the right to recourse against the goods seller, then how the ownership of the receivables will be handled. Under Article 14.1(k) of Circular 2/2017, a factoring contract must contain, among others, “provisions on the right to recourse to the debt and interest, factoring fees; content and time of transfer of rights and interests related to the receivables or payable amounts during the recourse process”. However, this Article does not specify whether or not the Credit Institution is required to re-transfer the receivables to the goods seller during the recourse process. Accordingly, the Credit Institution may continue owning such receivables, even if the goods seller has paid the Credit Institution the advanced amount, interest, and factoring fees because the receivables have been legally transferred to the Credit Institution from the starting time of factoring.
(b) With respect to debt sale and purchase activity: When the Debt Purchaser exercises the Cancellation Right, the Debt Purchaser is obliged to return the receivables to the Debt Seller and the Debt Seller is obliged to return the Purchase Price received from the Debt Purchaser in accordance with Article 427.2 of the Civil Code 2015.
2.4.3. At laws, Credit Institutions have the right to recourse to interest and factoring fees when exercising the right to recourse in factoring. Meanwhile, according to Article 427.2 of the Civil Code 2015, the Debt Purchaser only has the right to reclaim the Purchase Price (i.e., principal amount) upon canceling the Debt Sale & Purchase Agreement. When exercising the Cancellation Right, the Debt Purchaser has no right to require the Debt Seller to pay fees and interest under the provisions on contract cancellation of the Civil Code 2015.
2.4.4. Under the Debt Sale & Purchase Agreement, the Debt Seller must pay the Late Payment Interest to the Debt Purchaser when the Event of Default occurs. However,
(a) this is a contractual agreement and independent from the Cancellation Right; and
(b) it can be argued that the Late Payment Interest is not “factoring interest” since factoring interest arises even before the Credit Institution collects the receivables. Article 9.1 of Circular 2/2017 stipulates that factoring units and customers can agree on interest rates and factoring fees. Article 9.2 of Circular 2/2017 stipulates that if the factoring “interest" is not fully paid by the due date, the customer must pay late payment interest on the unpaid interest balance. Meanwhile, under the Debt Sale & Purchase Agreement, the Debt Seller is not required to pay the Late Payment Interest to the Debt Purchaser if the Goods Buyers pays the Receivables to the Debt Purchaser.
3. SOME RECOMMENDATIONS
3.1. In order to be consistent with the “cancellation of transaction” structure of the Civil Code 2015 and avoid the risk that the Cancellation Right upon occurrence of the Event of Default under the Debt Sale & Purchase Agreement is interpreted similarly to the right to recourse in factoring, the Debt Sale & Purchase Agreement should include the following provisions:
3.1.1. The debt sale and purchase transaction is a civil transaction with condition to cancel under Articles 120 and 423.1(a) of the Civil Code 2015, in which the condition to cancel the transaction is that the Goods Buyer fails to pay the Receivables to Debt Purchaser when due;
3.1.2. In case the Goods Buyer fails to pay the Receivables to the Debt Purchaser when due:
(a) the method to deal with this failure is to cancel the Debt Sale & Purchase Agreement under Articles 423.1 and 427 of the Civil Code 2015;
(b) Instead of applying the Late Payment Interest, the Debt Seller must pay the Debt Purchaser a penalty for breach due to the cancellation of the Debt Sale & Purchase Agreement. This provision will help to clearly indicate the nature of the debt sale and purchase transaction of the Debt Purchaser as interest-free which is different from factoring interest. In addition, this provision is also consistent with Article 427.1 of the Civil Code 2015 under which only provisions on penalty for breach and compensation for damage will survive after the cancellation of contract.
Regarding the method to determine the penalty, the Debt Purchaser should apply the penalty as a fixed amount not subject to elapsed time (example: 5% of the Purchase Price), and avoid using penalty calculation method having similar features of interest (e.g. the amount payable over the principal amount is proportional to the use period). In order to emphasize the nature of such amount as a penalty, such penalty will be limited to 8% of the Purchase Price in accordance with the provisions on limitation of penalty for breach under Article 301 of the Commercial Law of the National Assembly dated 14 June 2005; and
3.1.3. The Debt Sale & Purchase Agreement should specify that the cancellation of the contract and the payment of the penalty mentioned in 3.1.1 and 3.1.2 above are independent remedies.